Is It Worthwhile to Invest in Precious Metals?

A few weeks ago, I put out a call on Twitter and on Facebook for detailed posts that people would like to see. I got enough great responses that I’m going to fill the entire month of July – one post per day – addressing these ideas.

On Facebook, Silver requested a post on the topic of “Investing in precious metals – worth it?”

This is a question that doesn’t really have a straightforward “yes” or “no” answer. It has to do with a lot of other factors, risk tolerance being a big piece of it. Let’s walk through the whole picture.

How One Invests in Precious Metals

This investment takes two forms. Sometimes, people will buy the physical metal and store it somewhere privately. For example, people will often purchase gold and/or silver coins and keep them in their safe or in their safe deposit box at their bank. One person I know has several pounds in old gold coins sitting in their safe.

Another option is to buy a precious metal ETF. Essentially, this means you’re buying a stock whose price is tied to the current value of that precious metal, usually meaning that the ETF represents ownership of some small amount of that metal. If the value of the metal goes up, the value of the ETF goes up.

There are also ETFs that represent precious metal interests, such as ownership of silver or gold mines or refiners. These often track roughly with the rise and fall in value of precious metals, but not perfectly (they tend to be a bit less volatile, in my experience).

The Upside
There are several big pluses to investing in precious metals that many people point to.

One, it’s a physical commodity. If you own gold, you actually own a piece of that precious metal. This is opposed to things like a share of stock, which only exists on paper (as the company it’s a share of only exists on paper, in the end).

Two, it’s a limited commodity. There’s not an overabundance of any precious metal in the world. Yes, there is more mined all the time, but the total quantity isn’t growing at a very rapid rate.

Three, the price of precious metals often runs in the opposite direction of the United States and other Western economies. The recent enormous increase in the value of gold has come during a period of great weakness in the United States economy. The last big run-up in gold prices came during another period of great weakness in the economy. Many people once argued that the value run-up was a response to high inflation, but this most recent run-up has come during a period of very low inflation. The repeating pattern mostly seems to be a weak United States economy.

This means that people often move into gold when the United States economy looks weak (driving up the price) and they move out of gold when the United States economy looks economically strong (causing the price to drop). This is an extremely rough approximation.

Obviously, right now, people point to the tremendous recent jump in value in gold and silver as an example of how strong an investment in precious metals is. This is both a good and a bad.

It demonstrates that, yes, there are huge value jumps in precious metals that you can get rich off of. If you had bought gold at $300, you’d be rich now.

The Downside
In the short term, however, the big run-up in value in precious metals has already happened. If you’re looking to get rich quickly in precious metals, that ship has sailed. There may still be value increases, but the rocket ship ride that occurred in precious metals happened already over the past few years, and if you didn’t own precious metals during that period, you missed the rocket ship.

The huge upwards jump and the many recent rollercoaster-esque rises and dips in the values of precious metals demonstrates clearly the biggest flaw in investing in precious metals: they’re incredibly volatile investments. Jumps of 50% in value in a single year aren’t unusual over the history of precious metals, nor are drops of 50% in value.

In other words, right now we’re (at the very least) sitting fairly far up along the run-up in value of an extremely volatile commodity. This is not a place I want to be unless I’m truly hedging against something disastrous, and the only situation in which I’m doing that is if I’m convinced that other investments are going to lose the majority of their value in the very near future.

Thus, often, gold is sold alongside a healthy dose of paranoia. Much of the recent popularity in precious metals has come with gold sellers advertising on apocalyptic talk radio shows. Those shows spend a lot of time convincing people that the American economy is about to collapse and other apocalyptic facts so that the sales job for gold becomes much easier – which is exactly why gold sellers are happy to pay good money for these apocalyptic radio hosts to do the gold sales pitch for them. They both make money and the listener who buys in is left holding a very volatile investment near the top of its value.

(An aside: you would be shocked how often gold sellers want me to pitch their products to you. Often, they’re offering good money to do so.)

Another factor is that in a limited market like this, speculators run rampant. Every significant commodity market has speculators – people who are more interested in turning a short-term buck than earning money on a lasting investment. I don’t see anything wrong with speculation, but in order to compete with speculators, you have to really know what you’re doing in that market and very few individual investors do.

So, When Should One Invest?
I think that if you have a large portfolio of investments that includes a lot of other asset classes – domestic and foreign stocks, bonds, cash, foreign currency, real estate, and so on – precious metals might be another element you might want to include. Obviously, this element would be a very volatile piece of your investment picture, but you can balance that with other stable investments.

I would not buy precious metals unless I already had a significant amount of investments to counterbalance the volatility. If you don’t already have a lot of investments, buying precious metals means that you’re making the sum total of your investments incredibly volatile. You might wake up in three months to find that your life’s savings has lost 50% of its value.

I would absolutely not try to “play the gold market” (or the silver or the platinum market) unless I knew exactly what I was doing. In other words, if I had studied the markets extensively for years and had experience in short-term investing, I might try it. This excludes the vast majority of investors out there and most likely excludes you.

I would add that if you are going to move into a significant position of Gold and Silver, do so over a period of time to spread out the risk of volatility. Dollar cost averaging works with precious metals just as it does with other investments.

It’s true that precious metals carry volatility as do stocks and other commodities. However, compared to holding cash long term, precious metals are a much safer investment due to the continual devaluation of the dollar. The dollar has lost 97% of its value in about 100 years, not exactly an investment I would like to have over the long term.

Once precious metals reach a high point (& thus starts showing up on everyone’s radar), the best way for a lot of people to make money is to sell their unwanted jewelry to a reputable buyer. Buying metals works only when you shop it the way you would stocks – buy low & sell high.

What surprises me somewhat is that this is a popular question – I don’t know anyone who has expressed interest in buying gold or silver as an investment.

Trent, I don’t usually like to pick on your grammar, word choice, and writing style, but you have really got to get over your idea that “healthy” is an exact synonym for “large.” “Healthy dose of paranoia,” indeed. Is this a midwestern thing?

To #1, Interest rates are very low now, but if you add in the interest you can earn on cash it hasn’t done so badly over time. The downside of gold is that it doesn’t usually earn interest but rather costs money to store.

@jim: I didn’t check all 7 million of them, but the first few dozen all seem to refer to a “healthy dose of” something healthy, positive, or at least neutral. Not something negative, like paranoia. Wouldn’t a “healthy dose of paranoia” actually be a very small dose (and the smaller, the healthier)? That is the point I was trying to make.

I noticed something similar, too, in the last book review, where Trent talked about John Robbins having lost a “healthy portion” of his net worth to Bernie Madoff.

@ Johanna – it may be a Midwest thing. I am origInally from downstate Illinois (meaning not Chicago) and have always heard “healthly” to mean “large”. Regional dialects are interesting – when we moved to NC sometimes I felt like everyone was speaking a foreign language.

“If you don’t already have a lot of investments, buying precious metals means that you’re making the sum total of your investments incredibly volatile. You might wake up in three months to find that your life’s savings has lost 50% of its value.” Not just gold. A lot of people have recently lost 50% of the value of their houses, think Arizona and Nevada, Florida, and stock holdings. Diversify. A few ounces of gold around the house isn’t a bad thing. Jews escaped Nazi Germany by bribery using their jewelry, gold, silver. Pretty good return on your investment, your life and freedom vs the death camp. The hint above to look through your house and find any bits of gold and silver while teh price is high is a good one. Even tiny items and broken gold or silver jewelry have a value and can be easily translated into cash.

I’ve also heard that if you look at gold’s rate of return over long periods of time – say a decade or longer – then it barely outpaces the rate of inflation, if at all. I haven’t looked at the numbers to verify it myself, but if this is true then you can get a better return over the long run in many other types of investments.

Freedictionary cites a couple definitions that do include definitions that equate ‘healthy’ with ‘large’ though informally, example:
healthy [ˈhɛlθɪ]
adj healthier, healthiest
1. enjoying good health
2. functioning well or being sound the company’s finances are not very healthy
3. conducive to health; salutary
4. indicating soundness of body or mind a healthy appetite
5. Informal considerable in size or amount a healthy sum
healthily adv
healthiness n

ok, stupid investing question:
about 4-5 years ago i purchased a large amount of precious metal & mineral mutual funds that i couldn’t really afford (i didn’t know this at the time, but that’s why this question is stupid). i’ve held on to it and it’s appreciated nicely- currently it’s generated a 17.16% pre-taxes & fees return, but i’m worried that we’re at the top of the bubble.
it was an impulse investment and as i learn more about investing it might be foolish to hold on to it to the end of the bubble. it’s so volatile thought that its value changes drastically daily, so i’m afraid i’d sell it at a bad time.
should i kick it to the curb and buy all s&p index funds? or just keep sitting on it until i’m old and moldy?

cc @ 17: You probably have more choices than “never let go of any of it” and “dump it all”.

In general, you should have a diversified set of investments, so if the precious metal funds now make up a large portion of your portfolio, it may well a good idea to sell off *part* of it and buy other kinds of investments (such as the S&P index funds you mention) with the proceeds. Basically, decide what mix you want, and buy and sell accordingly.

Don’t worry about selling at the absolute best day; better to sell an investment when it’s a little off peak than wait till the whole thing has slid into a deep valley. (I’m not saying that this is necessarily imminent for precious metal funds, but given the historic volatility of such investments I consider it not unlikely that you’ll see such a slide before long.)

If you’re worried about selling your stake on a “bad day”, you may be able to spread out the sale into multiple installments, using dollar-cost averaging.

Julie- good point! But I’ll bet the amounts sold would be tightly controlled- as with diamonds. If it is known to be plentiful, then it is useless to the mining company also! Travel the the belt require a tremendous amount of fuel, so steps would be taken to make sure “scarcity” remained, or it would not be worth mining.

Paranoia can be healthy. Just because you are paranoid doesn’t mean they aren’t out to get you. If you look at the overall national and international political and economic scene, paranoia seems like the only rational response.

Use that paranoia to prepare for the worst. If it doesn’t happen, no harm done. If the worst does happen, then you are covered as much as you can manage.

Two comments:
@ The comment made by Trent that stocks are pieces of paper that represent value in a company that is only a piece of paper: Companies have both tangible and intangible assets, so while much of your value may be based on pieces of paper, services, patents, etc. some of the value of a stock comes from owning a piece of the actual infrastructure: the buildings, equipment, cash, etc.

@Josiah: The phrasing of “losing 97% of its value” is deceiving, as it only applies to holding cash in a whole in the ground. It is important to clarify your meaning of the word “safe”. In my mind, an asset that pays no income, that has an estimated real return of 0, and that has extreme volatility is not very safe. But to me safety refers to principal protection over the course of short to medium time frames.

Another consideration is taxes. Long term capital gain on sale of a stock is currently taxed at favorable rates of zero (10% next year) for lower income taxpayers and a maximum of 15% (20% next year), while gain on gold held for over a year is taxed at a flat 28%.

You can read any amount of prognosticating about gold going to $5,000 an ounce, but you could have read the same in the early 1980s; some people have been waiting 30 years for that to happen. What you wouldn’t have heard in the 1980s is that it could go as low as $250, but it did, and it may again.

I suspect it eventually will go to $5,000, but whether it will happen in my lifetime is a different matter. All I know for sure is that gold right now is about as high as it’s ever been in nominal price and much higher than average in real dollars. And the basic rule of good investing is to “buy low, sell high.”

By the way, if you bought gold at its early 1980s high of about $800 an ounce, you’d have to sell it today for about $2,600 an ounce to BREAK EVEN after taxes and dollar devaluation. The price now is about $1520 +/- $25. Those people who have been waiting 30 years have a while longer to go.

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